ACCOUNTING FOR RECEIVABLES STUDY OBJECTIVES After studying this material, you should understand:
TYPES OF RECEIVABLES Receivables are amounts due from individuals and other companies. There are three major classes of receivables:
PRIMARY ACCOUNTING ISSUES Recognition Valuation Disposition
RECOGNIZING A/R A classic general journal sequence for credit sales.
VALUATION OF A/R • Receivables are current assets on the balance sheet • They are stated at net realizable value, the amount expected to be received in cash. • Uncollectible A/R are accounted for using two methods Direct Write-Off Method Allowance Method
DIRECT WRITE-OFF METHOD • No entries are made for bad debts until an account is determined to be uncollectible at which time the loss is charged to bad debts expense. • Bad debt expense shows only actual losses. • Not acceptable for financial reporting purposes unless losses are insignificant. Operating expense on the income statement Bad debts expense
DIRECT WRITE-OFF METHOD General Journal Date Account Titles Debit Credit Dec. 12 Bad Debts Expense 200 Accounts Receivable – M.E. Doran 200 Warden Co. writes off M. E. Doran’s $200 balance as uncollectible on December 12. When this method is used, Bad Debts Expense will show only actual losses from uncollectibles.
ALLOWANCE METHOD • The allowance method is required when bad debts are material. • Uncollectible accounts are estimated • The expense is matched against sales in the same accounting period. Uncollectible accounts expense = bad debts expense
ALLOWANCE METHOD RECORDING ESTIMATED UNCOLLECTIBLES General Journal Date Account Titles Debit Credit Dec. 31 Bad Debts Expense 12,000 Allowance for Doubtful Accounts 12,000 Estimated uncollectibles are debited to Bad Debts Expense and credited to Allowance for Doubtful Accounts at the end of each period.
ALLOWANCE METHOD RECORDING A WRITE-OFF General Journal Date Account Titles Debit Credit Mar. 1 Allowance for Doubtful Accounts 500 Accounts Receivable - R. A. Ware 500 Actual uncollectibles are debited to Allowance for Doubtful Accounts and credited to Accounts Receivable at the time the specific account is written off.
ALLOWANCE METHOD RECORDING A RECOVERY To recover an account that has been written off: 1 reverse the write-off entry. General Journal Date Account Titles Debit Credit July 1 Accounts Receivable – R. A. Ware 500 Allowance for Doubtful Accounts 500 2 record the collection in the usual manner. General Journal Date Account Titles Debit Credit July 1 Cash 500 Accounts Receivable 500
ALLOWANCE METHOD BASIS FOR ESTIMATING UNCOLLECTIBLES Two methods of estimating uncollectible accounts comply with GAAP. Percentage of Sales Percentage of Receivables Emphasis on Income Statement Relationships Emphasis on Balance Sheet Relationships Uses aging schedule
Dec.3 1 Bad Debts Expense 8,000 Allowance for Doubtful Accounts 8,000 ALLOWANCE METHOD PERECENTAGE OF SALES BASIS • Bad debt expense is based on a % of current credit sales estimated to be uncollectible, based on past experience. • Matches expenses with revenues. • No consideration given to existing balance in the allowance. If net credit sales for the year are $800,000, the estimated bad debts expense is $8,000 (1% X $800,000).
ALLOWANCE METHOD PERECENTAGE OF RECEIVABLES BASIS • Bad debt expense based on % of the ending balance in A/R. • The adjusting entry is the difference between the required balance and the existing balance in the allowance account. • Estimates NRV of receivables. General Journal Date Account Titles Debit Credit Dec. 31 Bad Debts Expense 1,700 Allowance for Doubtful Accounts 1,700 If the existing balance in the allowance account is $500 credit, and the required balance is $2,200, the journal entry to increase the allowance will be for the difference between the required balance and the existing balance.
If the existing balance in the allowance account is $500 debit, and the required balance is $2,200, the journal entry to increase the allowance will be for the sum of the required balance and existing balance. General Journal Date Account Titles Debit Credit Dec. 31 Bad Debts Expense 2,700 Allowance for Doubtful Accounts 2,700
REVIEW QUESTION Which of the following approaches for bad debts is referred to as a balance sheet method? • Percentage of receivables method • Direct write-off method • Percentage of sales method • Both a and b Answer: (A) Percentage of receivables method.
FINANCIAL STATEMENT PRESENTATION & ANALYSIS • In the balance sheet, short-term receivables are reported in the current assetssection belowshort-term investments. • Report both the gross amount of receivables and the allowance for doubtful accounts.
Average Net Receivables Accounts Receivable Turnover Net Credit Sales A/R TURNOVER RATIO • Financial ratios are computed to evaluate the liquidity of a company’s accounts receivable. • The accounts receivables turnover ratio is used to assess the liquidity of the receivables. • The data below is from Cisco Systems: = / • $18,878 / ( $1,105 + $1,351)/2 = 15.4 times
AVERAGE COLLECTION PERIOD • The average collectionperiodin days is a variant of the turnover ratio that makes liquidity even more evident. • This is done by dividing the turnover ratio into 365 days. • The general ruleis that the collection period should not exceed the credit term period. • Cisco System’s turnover ratio is computed as: Days in year A/R Turn Ratio Average Collection Period = / 365 / 15.4 23.7 days